Chapter 4. Deductions. Topics. Also: Alimony Business deductions Marijuana operations

Transcription

1 Chapter 4 Deductions 1 Topics Also: Alimony Business deductions Marijuana operations 2

2 Medical Expense Deduction 3 ACA / 213 reminder Medical limited to amount in excess of 10% of AGI 7.5% of AGI if taxpayer or spouse is 65 or older on last day of the tax year Starting in 2017, everyone uses 10% threshold. 4

3 Taxes Deduction 5 State income tax on p/s income Cutler, TC Memo (4/9/15) Lawyer and ptr in law firm p/s Operates in a few states Paid state income taxes as non-resident Treated as above the line deduction (Sch E) Are entity-level taxes imposed through w/h C performed no services in at least one of the states IRS and Court itemized deduction only Just because state requires p/s to w/h, doesn t make it a p/s tax. State taxes p/s as a passthrough. C had authority to manage p/s business in the states. 6

4 Mortgage Interest Deduction 7 New Information on Forms 1098 PL (7/31/15) change to 1098 New items to be reported: Mortgage origination date Outstanding principal amount at beginning of TY Address of property securing the debt. Why? Help reduce tax gap. When? For 1098s required to be furnished after 12/31/16 To give lenders time to get ready. 8

5 Mtg interest, joint liability and separate returns CCA (12/19/14) 3 fact patterns involving H&W, unmarried couple and relatives Co-own property and joint and several liability on the mortgage Basically If payment is from separate funds that payor claims the deduction. If payment from joint funds split 9 QRI Debt Limits are Per Taxpayer, Not Per Residence Voss and Sophy, 796 F3d 1051 (9 th Cir., 8/7/15) 9 th Circuit overturned 2012 Tax Court decision Debt limits of 163(h) apply per taxpayer rather than per residence Statute not clear. Language used for MFS interpretation supports per taxpayer rather than per residence. Challenges of using per residence (so not likely the intent). No problem that results in marriage penalty. 10

6 Owned by two RDPs as Joint Tenants Rancho Mirage Beverly Hills IRS calc of allowable interest - Sophy Total qualified loan limit $1,100,000 $1,100,000 Total average balance of all mortgages $2,703,568 $2,669,136 on all qualified loans Limitation ratio Total amount of interest paid by Sophy $94,698 $99,901 Deductible mortgage interest $38,530 $41,171 Claimed $95,396 $65,614 From Tax Court decision. 12

7 9 th - It is clear that each spouse in a MFS couple has a total limit of $550,000. Suggests that debt limits are per taxpayer, not per residence. 13 Next step for IRS? Appeal? Acq? Non-acq? Nothing? Remember, IRS won in Tax Court. 14

8 Observations Voss/Sophy California treats them as married (RDP). If followed IRS interpretation for client consider amending. Watch to see if any mention in Pub 936. Will Congress act? If take view of IRS now a revenue raiser. 15 Relevance to cohabitation decisions Two unmarried individuals Can have two principal and two second homes (each). Can have $2 million acquisition debt and $200K home equity debt (as long as each along doesn t exceed debt limit). If married Can have one principal and one second home. Can have $1 million AI and $100K HEI. 16

9 Mortgage interest and equitable owner Phan, TC Summary Op (1/12/15) Name not on mtg of mother s home, but P made payments in 2010 and claimed deduction of ~$36, (b) may deduct mtg interest paid if are legal or equitable owner of the property 2010 M&F divorce; M unable to care for property; P lives in home; pays mtg, tax and insurance; performed mtc and made improvements Legal title held by M, F and P s brother 2011 refinance 2013 P added to legal title Ct found credible evidence of beneficial ownership 17 Factors showing beneficial ownership - 1 Look to state law (here, California) Owner of legal title presumed to also be owner of beneficial title May rebut with clear and convincing proof P needs such evidence to show had beneficial o/s interest Under California law an individual may overcome the presumption that the legal owner is also the equitable owner by showing that there exists an agreement or understanding between the parties evidencing an intent contrary to that which is reflected in the deed. 18

10 Factors showing beneficial ownership - 2 From prior tax cases: 1. Right to possess property and enjoy use, rents or profits. 2. Duty to maintain the property. 3. Responsibility to insure. 4. Bear risk of loss of the property. 5. Obligation to pay property taxes. 6. Right to improve the property w/o owner consent. 7. Right to obtain legal title at any time by paying balance of purchase price. Ct P has beneficial ownership; may deduct mtg interest 19 Minchem International, Inc., TC Memo (March 24, 2015) Excess Over Home Equity Debt Interest Not Allowed as Investment Interest

11 T $1.7 Mil. Debt Minchem Inc. T The Tax Court denied the taxpayer an investment interest expense deduction for portion of loan in excess of the home equity debt (QRI).

12 The [taxpayers] posit that Minchem is property held for investment because it is a type of property that generally produces dividend income. Observation: Taxpayer made wrong argument: Loans produce interest not dividends

13 What is investment interest income? [g]ross income from property held for investment (Section 163(d)(4)(B)(i)) The term property held for investment shall include any property which produces income of a type described insection 469(e)(1) (Section 163(d)(5)(A)(i))

14 [G]ross income from interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business (Section 469(e)(1)(A)(i)(I) Tax Court in Minchem: Instead, Minchem's general ledger notes that the company treated the mortgage proceeds as a personal loan from [taxpayer] to Minchem.

15 Worse: [I]t does not appear that Minchem was required to pay interest on loans from [taxpayer] The Tax Court also criticized the taxpayer for failing to distinguish the simplified method or the exact method as applying to the calculation of QRI

16 Per the Tax Court, the simplified method treats remaining paid interest as nondeductible personal interest even if the remaining interest would [potentially be investment interest] Reg T(d)(2) CCA Excess interest can be investment or business interest regardless of the method use to determine QRI (also in Pub 936)

17 CCA May use any reasonable method, including exact method, to determine amount deductible as QRI when debt exceeds acquisition and/or home equity debt limitations. Regardless of which reasonable method is used, taxpayer may allocate te amounts that exceed limitations in accordance with use of the debt proceeds, as provided in section t(e)(4) and the instructions to line 13 of Pub 936. If not AI or HEI, then apply usual tracing rules of T.

18 Per CCA - No need to make T(o)(5) election to apply tracing rules of T to debt that exceeds mtg interest limits T(o)(5) election applies to whole debt, not part. If debt is not AI or HEI because other debts already meet the limits, no need to elect to treat as not secured by a QR. Also, the election can be made anytime.

19 In Minchem, government failed to prove civil fraud but the Tax Court did agree with negligence penalty (60 page opinion) Review Computing mortgage interest deduction when debt limitations are exceeded 38

20 Per CCA , methods include Exact method T(e) Debt by debt analysis If not QRI, use tracing rules to classify Simplified method T(d) Combine debts for calculation Since enactment of OBRA 1987 the $1,000,000 acquisition indebtedness limitation and $100,000 home equity indebtedness limitation must be substituted for the adjusted purchase price. Treat excess debt as personal, non-deductible. Pub 936 method Similar to simplified Classify excess debt per tracing rules (not automatically personal) a reasonable approximation of those methods 39 Example Exact method Nathan has 1 QR and total debt of $1.3 million: AI $900,000 Exact Equity debt #1 $250,000 (used for personal purposes) Equity debt #2 $150,000 (used for Schedule C expenses) AI of $900,000 all interest deductible Equity #1 only 10/25 deductible (Sch A) Equity #2 all deductible (Sch C) Check to see if any of #1 used for substantial improvements to QR, which would make up to $100K AI.

21 Example Simplified method Simplified $1,000,000 $1,300,000 (total debt) 76.9% deductible on Schedule A 1. Per regs treat balance of int exp as personal and nondeductible (caution don t do this!) 2. Per Pub 936 see instructions for line 13 of Table 1 (do this instead) If you used the proceeds of the mortgages for more than one activity, then you can allocate the interest [that is not QRI] among the activities in any manner you select. So, of $300,000 that is not producing QRI, seems reasonable to treat 50% as business and 50% as personal, since can trace $150,000 to trade or business expenses. Why are we still using temporary regs? Regs T, -9T and -10T were all issued before 11/20/88 so don t expire! Obviously low priority at IRS to finalize. So, have modifications by notices, rev ruls and Publications! 42

22 Interest Income rather than Return of Principal Friedman, TC Memo (9/10/15) Parents loaned about $5 million to daughter s S corp Notes written with stated interest. Interest paid by corp monthly Ps only reported part of it and claimed $3,000 capital loss (believed debts would not be repaid) Applied open transaction doctrine argument (to support that part of the interest payments were really return of principal). Court it s interest per all facts; not shown to be worthless; substantial understatement of tax penalty as no substantial authority to support tax treatment claimed. 43 Notice (11/6/2015) Government Assistance Safe Harbor Extended through 2017

23 An updated list of State Programs for which the Treasury Department approves funding is available at

24 California $2 Billion For taxable years 2010 through 2017, a homeowner may deduct [on Form 1040] the lesser of- The sum of all mortgage payments during a tax year to the mortgage servicer or State Housing Finance Agency; and

25 The sum of amounts shown on Form 1098 for mortgage interest received, real property taxes, and mortgage insurance premiums (if deductible under 163(h)(3)(E)). Charitable Contribution Deduction 50

26 Charitable Contribution Documentation Beaubrun, TC Memo (11/16/15) Numerous donations mostly of $250 or more. IRS and Tax Court charity is valid. Cancelled checks and incomplete and late statement from charity are not enough under 170(f)(8). Contemporaneous written acknowledgement must Be rec d before file return. Indicate whether donor rec d any goods or services in exchange for the contribution. 51 IRC 170(f)(8) 52

27 Charitable contribution reminders Jalloh, TC Summary Op (3/9/15) Contributions $15,340 cash and $15,697 non-cash (2 cars) $6,490 cash and $3,867 noncash IRS disallowed all other than $500 for one car Lack of substantiation No records or undated and not contemporaneous written acknowledgements (if $250 or more) Vague descriptions on Form 8283 Court agree with IRS 53 More reminders Kunkel, TC Memo (4/8/15) Claimed 2011 donations: $5,140 cash (IRS disallowed $300) $37,315 noncash to 4 charities (IRS denied all) Including $8,000 books, $1,000 clothing to a church No receipts or acknowledgement or other evidence (such as photos) Including $20,950 clothing to Goodwill and 2 other charities No documentation Often dropped off after hours in batches worth under $250 as K thought this eliminated need for receipt Some items picked up at their house K says listed on index cards, but could not produce them 54

28 Do you think Kunkel won or lost? 55 Court dug into details and their meaning K allegedly donated property worth $13,115 to the Church; this donation occurred in conjunction with a single event, the Church s annual flea market. Petitioners testimony that they intentionally made all other contributions in batches worth less than $250 requires the assumption that they made these donations, with an alleged value of $24,200, on 97 distinct occasions. This assumption is implausible and has no support in the record. Court if did not assign values until return filed, how did they know each batch worth < $250? 56

29 Kunkel - continued Each category has alleged value > $500. Footnote 3 Petitioners argue that they were unaware of the requirement to aggregate property. But they testified that they relied on IRS Publication 526, Charitable Contributions, in preparing their 2011 return. That publication specifically instructs taxpayers that, [i]n figuring whether your deduction is $500 or more, [you must] combine your claimed deductions for all similar items of property donated to any charitable organization during the year reminders from Tax Court Even if value < $250, still need record that documents the donation ( 1.170A-13(b)(1)) If value > $500, need add l records date, description, cost/basis, FMV, method to compute FMV Clothing and HH items must be in good used condition or better Need some type of proof or appraisal K s effort = negligence; 6662(a) penalty applies. 58

30 Form 8283 Must Be Filed if Noncash Gifts Exceed $500 Grouping Rule Reg A-13(c)(1) For purposes of (c), amount claimed or reported as a deduction for an item of property is the aggregate amount claimed or reported as a deduction for a charitable contribution under 170 for such items of property and all similar items of property (as defined at (c)(7)(iii)) by the same donor for the same tax year(whether or not donated to the same done). Form 8283: 60

31 Similar items Reg 1.170A-13(c)(7)(iii) Property in same generic class, such as: Books Stamps Coins Non-publicly traded stock Jewelry Furniture Toys Appliances Electronic equipment 61 Example - Reg 1.170A-13(c)(7)(iii) Sally donates books valued at: $2,000 donated to SJSU $2,500 donated to San Jose Public Library $900 donated to Homeless Shelter Total exceeds $5,000 SO Sally must: a) get a qualified appraisal b) attach 3 appraisal summaries for books donated to each charity 62

32 Qualified Appraisal Reg A-13(c)(3) Appraisal document must Made within 60 days of the donation date. Prepared, signed and dated by qualified appraiser (-13(c)(5)) Include info per -13(c)(3)(ii) A. Description of property in detail B. If tangible property, the physical condition C. Date or expected date of contribution D. Terms of any agreement or understanding between donor and done E. Name, address ID number of qualified appraiser F. Qualification of the qualified appraiser G. Statement that appraisal prepared for income tax purposes H. Date of appraisal I. Appraised FMV J. Valuation method used K. Specific basis for the valuation Not involve an appraisal fee prohibited by -13(c)(6) 63

33 65 66

34 Form 8283 Part A if the group of items does not exceed $5,000 67

35 Items Claimed value Clothing Part B $21,920 Books Part B 8,000 Household furniture Part A 3,090 Household items Part A 1,653 Toys Part A 1,072 Telescopes Part A 800 Jewelry 780 Part A Total 37, Isaacs, TC Memo (6/30/15) T donated 4 fossil trilobites to California Academy of Sciences Claimed value $136, donated 8 Claimed value $109,800 Letters from CAS noted the donations but not whether T rec d goods or services in exchange Form 8283 signed by appraiser (A) who did not recall signing the form. Also 2 letters from A but A says did not write them. IRS disallowed the charitable donations. 70

36 (1) $250 or more threshold 170(f)(8) and Reg A-13(f)(2) Contemporaneous written acknowledgement (CWA) from charitable org Rec d by due date of return (incl extension) Must include: 1) Description of non-cash property donated (no value needed). 2) Whether done provided any goods or services in exchange for the donation. 3) Description and good faith estimate of value of any goods or services provided by charitable org. 71 (2) Noncash > $ (f)(11)(A) and 1.170A-13(b)(2) & (3) Must keep reliable written records of each donated item that show: 1) Approximate date and manner of acquiring the property. 2) Description of property in detail reasonable under the circumstances. 3) Cost or other basis of the property. 4) FMV of the property at time of donation, and 5) Method for determining FMV. 72

37 (3) Noncash > $5, (f)(11)(C) and 1.170A-13(c)(2) In addition to items (1) and (2) Qualified appraisal of donated items Attach fully completed appraisal summary on Form With info listed earlier (A) (K) 73 Court 3 value thresholds applied Requirement: (1) Donations of $250 or more ( 170(f)(8)) Problem Letter lacked statement that donor rec d nothing from donee (170(f)(8)(B)(ii)) (2) Noncash > $500 No written record maintained (3) Noncash > $5,000 No appraisal 74

38 And 170(f)(16) Contributions of clothing and household items 75 And 170(f)(17) Recordkeeping No deduction shall be allowed under subsection (a) for any contribution of a cash, check, or other monetary gift unless the donor maintains as a record of such contribution a bank record or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution. Does your client have cancelled checks? Record of cash dropped in collection plate? 76

39 Conservation Easement Donations Minnick, No (9 th Cir., 8/12/15; not for pub) 9 th Circuit agreed with Tax Court s disallowance and negligence penalty Problem due to mortgage subordination agreement. Negligence penalty appropriate M had law degree and should have read the reg 77 Due Diligence Ask questions regarding what was donated, value, how determined, documentation. Convince clients to contact you before making donations greater than $249. Share some of the cases to convince them. 78

40 What do you think? Donation of $400 Letter from donee: ABC Foundation benefits are available to donors of $100 or more. If you declined benefits, the entire amount of your contribution is tax deductible. If you accepted benefits, 80% of your contribution for events (less the fair market value of the benefits received) are tax deductible. 79 Proposed Info Reporting System for 170(f)(8) REG (9/17/15) Allowed per 170(f)(8)(D) but IRS rec d few requests for alternative reporting But current contemporaneous written acknowledgement system has weaknesses Donor might not get the letter or keep it Letter might not meet 170(f)(8) req Proposal Optional info reporting with the CWA info AND Donor name, address and TIN Forms due to IRS and donors by Feb 28 80

41 Alimony Deduction 81 Crabtree, TC Memo (8/17/15) Divorce agreement needs to state all requirements for alimony. Here, payments to be made for 8 years but would end if W remarried or co-habituated. No mention of ending at W s death. Court will ck state law to see if that addresses issue. Here, state law ambiguous so court when with agreement text. Not alimony no income to W. 82

42 Wish, TC Summary Op (4/6/15) If W stopped homeschooling child, monthly spousal support decreased 2009 W stops homeschooling; returns to work Child still schooled IRS child related contingency; not alimony Court reduction ties to W returning to work so needs less support Deductible alimony. 83 Milbourn, TC Memo (1/21/15) W filed complaint for absolute divorce in Tenn. Draft marital dissolution agreement (MDA) existed. H made payments in 2006 Deducted as alimony. Court not alimony! No binding document MDA not signed so just a unilateral offer by W to enter separation agreement. No mutual assent of the parties. 84

43 Business Deductions 85 Business record problems Problems: No records or the wrong records. Deducting personal items Paying children (or at least issuing them W-2s) Deducting household items when no space is used regularly and exclusively as home office. Claiming home office expenses when have principal place of business elsewhere. Documenting gifts over one year after given. Claiming standard mileage on vehicle not owned or leased. Insufficient documentation. 86

44 280F Limits Rev. Proc (2/6/15) Vehicles placed in service in Limits for: Passenger autos Trucks and vans 1 st tax year $3,160 $3,460 2 nd tax year $5,100 $5,600 3 rd tax year $3,050 $3,350 Each succeeding tax year $1,875 $1, Mileage rates for 2015 Notice per mile for business miles driven 56 in is for depreciation 23 per mile for medical or moving purposes 23.5 in per mile for charitable Same as 2014 (set by statute) 88

45 Motor Home Miles Must Document! Cartwright, TC Memo Dr. C on-call physician and surgeon Navigator motor home to drive from home to hospital Rest and sleep in it in parking lot at hospital Reviewed patient charts there. Claimed depreciation and 179 Business use claimed % % Documents showed: 27 days in 2008 and 36 days in 2009 Bonus 20% accuracy related penalty! 89 When does business begin Tarighi, TC Summary Op (4/13/15) Civil engineer Worked as EE many years Intent to start own business Business cards, website, effort to get work But still working for ER Filed Sch C with losses for 2009 and 2010 IRS not in business no clients, no bids made, no income 90

46 Tarighi - continued Can t deduct expenses until: Functioning as going concern Performing activities organized to perform Expenses occurred when above conditions exist Facts and circumstances test Above not met for T Made no bids on jobs Sch C expenses are 195 start-up expenses So did not consider whether properly substantiated 91 Patent Litigation PLR (9/4/15) T incurred litigation costs for alleged infringement of patent by 3 rd party. T licensed patent from affiliate and had obligation to defend with affiliate and T sharing costs and rewards Deductible? IRS yes because not defending title Origin of the claim Whether an amount is paid to defend or perfect title, or to protect against infringement, is a factual matter. 92

47 Marijuana Operations 93 A Growth Industry Medical use 23 states + DC Recreational use 4 states + DC Ballot initiatives likely in California and a few others states Colorado marijuana taxes and fees Approximately $11 million per month Over 4,000 attendees at 4 th Annual Marijuana Business Conference and Expo in Nov 2015 in Las Vegas Ralph Nader was keynote speaker Presentations on business development, cultivation, products, and more. 94

48 IRC 280E - Expenditures in connection with the illegal sale of drugs No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted. 95 Marijuana business and 280E CCA (1/23/15) - two questions. How is COS determined for taxpayer subject to 280E? Determine using applicable inventory-costing regs under 471 as they existed when 280E was enacted. May IRS require taxpayer to use an inventory method for the controlled substance? Yes, unless the taxpayer is properly using a noninventory method to account for the controlled substance pursuant to the Code, Regulations, or other published guidance. 96

49 280E and Marijuana Operations Olive, 139 TC No. 2 (2012), aff d No (9 th Cir., 7/9/15) Poor recordkeeping and personal use of inventory 280E applies even if operation allowed under state law. If give away free items along with sale of marijuana, that is not a separate T or B (not like the CHAMP case (128 TC No. 14 (5/15/07)). 97 Marijuana operation problems Beck, TC Memo (8/10/15) Operated 2 dispensaries in CA DEA search and seizure at 1 in January 2007 IRS disallowed expenses, seized drugs IRS assessed SE tax and penalties Over $1 million of tax + $210K of penalty Court agreed B subject to 280E No 162 or 165 items Observations: DEA can show up, problems for any preparer of cash client that destroys records daily 98

50 Excise Taxes Paid by Marijuana Business CCA (7/31/15) Washington imposes excise taxes on marijuana sellers, processors and producers. IRS under 164 on state taxes treat expenditure as reduction in amount realized on sale of property rather than as inventoriable cost or deduction from gross income. 280E no problem because excise tax is neither a deduction from gross income nor a tax credit. 99 Check if any client needs to amend per Voss holding. Spare time review T and Notice 89-35; and QRI rules. Remind clients of charitable contribution documentation and appraisal rules and emphasize that NO EXCUSES! Share some of the cases with them. If clients mentions divorce remind them you can help be sure alimony is IRC alimony. Marijuana clients? Review new cases.